Bank of England's latest Financial Stability Report

29-Jun-2018

The
Financial Policy Committee (FPC) aims to ensure the UK financial system is
resilient to, and prepared for, the wide range of risks it could face — so that
the system can serve UK households and businesses in bad times as well as good.

The
FPC continues to judge that, apart from those related to Brexit, domestic risks
remain standard overall. In recent months there has been some reduction in
domestic risk appetite, although it remains strong.

Levels
of household and corporate debt in the UK relative to incomes remain materially
below their 2008 levels. Overall, credit growth remains broadly in line with
the growth in nominal GDP and debt‑servicing burdens are
low.

In
recent months, corporate bond spreads have increased and mortgage loan spreads
have widened a little.

Non‑bank
lending to riskier companies has been expanding rapidly. But lending by banks
has been muted, limiting the increase in overall corporate leverage and the
effect on banks’ resilience.

Consumer
credit continues to expand rapidly. The Committee acted last year to ensure
lenders are able to absorb severe losses on consumer credit.

Although
banks’ risk appetite in mortgage lending has increased over the past few years,
weak demand has kept mortgage credit growth modest. The FPC’s previous mortgage
market measures have insured against a marked deterioration in lending
standards.

Risks
from global vulnerabilities remain material and have increased.

Increases
in Italian government bond yields suggest rising risks in the euro area and
underline the vulnerabilities

created
by high public debt levels and interlinkages between banks and sovereigns in a
currency union.

Tightening
conditions in US dollar funding markets are increasing risks in some emerging
markets.

Trade
tensions have intensified. Debt levels in China remain highly elevated. And
corporate leverage in the US has continued
to increase.

The
2017 stress test showed that the UK banking system is resilient to severe
domestic, global and market shocks. The FPC is maintaining the UK countercyclical
capital buffer (CCyB) rate at 1%.

Major
UK banks’ capital strength has tripled since 2007, with an aggregate Tier 1
capital ratio of 17% in 2018 Q1.

The
FPC remains alert to any increase in risks faced by the UK banking system.
Financing conditions in debt markets, which remain accommodative, could promote
further risk‑taking in the UK and elsewhere. The UK is more
vulnerable to a reduction in foreign investor appetite for UK assets, as the
share of capital inflows vulnerable to refinancing risk has risen. And material
global risks could spill over to the UK.

The
FPC will conduct as normal a comprehensive assessment of the resilience of the
UK banking system in the 2018 stress test and review the adequacy of the 1%
CCyB rate.

The
FPC continues to judge that the UK banking system could support the real
economy through a disorderly Brexit.

The
2017 stress test encompassed a wide range of UK macroeconomic outcomes that
could be associated with Brexit. As it has set out previously, the FPC judges
that Brexit risks do not warrant additional capital buffers for banks.

Irrespective
of the particular form of the UK’s future relationship with the EU, and
consistent with its statutory responsibility, the FPC will remain committed to
the implementation of robust prudential standards in the UK. This will require
maintaining a level of resilience that is at least as great as that currently
planned, which itself exceeds that required by international baseline
standards.

The
FPC is continuing to monitor preparations to mitigate disruption to financial
services that could arise from Brexit. Progress has been made but material
risks remain.

An
implementation period has been agreed, subject to finalisation and ratification
of the Withdrawal Agreement between the EU and the UK, elements of which are
still in negotiation.

The
EU (Withdrawal) Bill has been passed by Parliament.

The
UK Government has committed to legislate, if necessary, to put in place a
temporary permissions regime to enable EU‑based financial
companies to continue to provide financial services to UK end‑users.
Once enacted, this will mitigate a number of risks of disruption to UK
customers.

The
biggest remaining risks of disruption are where action is needed by both UK and
EU authorities, such as ensuring the continuity of existing derivative
contracts. As yet the EU has not indicated a solution analogous to a temporary
permissions regime. The FPC welcomes the establishment in April of a technical
working group, chaired by the European Central Bank and Bank of England, on
risk management in the area of financial services in the period around 30 March
2019.

The
FPC is setting standards for how quickly critical financial companies must be
able to restore vital services following a cyber attack. It plans to test them
against these in cyber stress tests.

Firms
have primary responsibility for their ability to resist and recover from cyber
attack.

The
impact tolerances being established by the FPC will be based on the time after
which disruption to services could cause material economic impact.

Working
with others, especially the National Cyber Security Centre, the Bank will test
that firms would be able to meet the FPC’s standards for recovering services.

Continued
reliance of financial markets on Libor poses a risk to financial stability that
can be reduced only through a transition to alternative rates. The FPC will
monitor progress and report regularly.

The
scarcity of unsecured deposit transactions poses a risk to the medium‑term
sustainability of Libor. The FCA has secured agreement of Libor panel banks to
submit to Libor until end‑2021.

Good
progress has been made to establish potential alternatives to Libor. In the UK,
SONIA (the sterling overnight index average) is the preferred alternative. And
two important market‑led consultation exercises are due to be
carried out soon.

However,
as long as the outstanding stock of contracts maturing after 2021 that
reference Libor continues to increase, so will associated medium‑term
financial stability risks.